Surplus a distraction from key issues

Plans to return to a budget surplus this financial year already look unrealistic. In large part this is because commodity prices have fallen, weakening tax revenues. While further spending cuts and tax increases could be made, the more economically responsible tactic would be to allow the budget to stay in deficit for another year.

The government’s plan to get back to budget surplus this year was always ambitious. Global growth has slowed and this financial year is one of only two years in the past decade when commodity prices have fallen.

To get back to surplus also requires a massive swing in the budget bottom line. The government’s mid-year fiscal update set out plans to swing the budget by 3.1 per cent of GDP, from a $43.4 billion deficit to a $1.1 billion surplus in 2012-13. This would be the largest budget swing in Australia in over 40 years and also one of the largest in the developed world. The much feared US “fiscal cliff”, which threatens to push the US economy back into recession, is not a whole lot larger, with a planned budget swing of 4.3 per cent of GDP.

Much like in the US, Australia’s budget plans have also become more of a political than an economic imperative. In Australia’s case, meeting a long-held commitment to achieve a fiscal surplus by 2012-13 is being used as “proof” by the current left-leaning government of how fiscally responsible it can be.

While this political imperative could be important for the government’s re-election chances, the economic rationale for the need to return to surplus this year is weak. Unlike other countries, Australia does not have burgeoning debt levels or concerns about access to international funding markets. Australian government debt is low – at below 10 per cent of GDP in net terms – and the sovereign has a triple-A rating which has seen foreign ownership of government bonds recently rise to a record 77 per cent.

Indeed, the budget plans are now likely to present a downside risk to economic growth. If tax revenues surprise on the downside, more spending cuts or tax rises would further depress growth in an already slowing economy. Australia could face its own version of a fiscal cliff.

The current budget plans also raise questions about whether the mix of monetary and fiscal policy is appropriate. Arguably, the RBA has had to cut rates further than it might otherwise have done, due to the government’s fiscal policy choices.

With the RBA’s cash rate now back at a historical low of 3 per cent, further government cuts would risk leaving the RBA with limited room to move in the event of another negative shock to the economy. Further tightening of fiscal policy could see a political imperative overrule an economic imperative. That is rarely a good way to make policy.

The public discussion and political commentary about whether a budget surplus will be achieved, or not, is also somewhat unhelpful, as it distracts from the more important issue of how this should be achieved.The composition of taxation and spending decisions is far more important than whether the government registers a small surplus or deficit in a particular fiscal year.

On this front, recent developments are a concern. Australia’s tax base has been eroding. The tax system has not kept pace with structural changes in the economy. The OECD’s recent review of Australia puts tax reform high on the list of key policy recommendations, suggesting that the mining tax be expanded and the GST broadened.

Demographics are also starting to weigh on tax collection, with employment past its peak share of the population. The government’s health spending commitments will increase as the population ages. There are also key questions about the role of the public sector in infrastructure provision, particularly in an environment when 10-year government bond yields are around record lows, allowing the government to lock in cheap funding.

With an election next year, the hope is for more political discourse that takes these broader issues of tax reform and the role of the government in our economy seriously. These are far more important issues than whether a budget surplus will be achieved this year.